Gaynor: Trading jitters hit the rural sector

By BRIAN GAYNOR

Rural companies were in the news this week with profit warnings from Affco and Richmond, and results from Fonterra and Pyne Gould Guinness (formerly known as Reid Farmers).

The announcements indicated that some companies have benefited from the strong performance of the rural sector but others are struggling to produce acceptable returns for shareholders.

Affco's annual meeting was a low-key event that lasted just 33 minutes. The shortage of questions was a big surprise because the company had a difficult year and many farmer-shareholders travelled to Auckland for the meeting.

In the past year chief executive Ross Townshend resigned, receiving a big golden handshake, and chairman Sam Lewis effectively became chief executive. Motueka-based Talleys Fisheries acquired a 10 per cent holding through the placement of new shares and Affco had a one-for-five rights issue at 25c.

More importantly, net profit for the September year was only $600,000, compared with $15.2 million in the previous year. Last year's result was worse than it looked because it included $7.9 million of writebacks on assets that were written down in an earlier period.

The poor result reflects several industry problems, especially the sharp fall in sheep and beef cattle numbers. Sheep numbers have dropped from 70.3 million in 1982 to 45.7 million, and beef cattle from 6.3 million in 1975 to 4.6 million.

As a result, competition for stock is intense and has resulted in higher prices for farmers and lower margins for meat producers. Last year, farm-gate prices rose an average 18 per cent for beef and 27 per cent for lamb.

Mr Lewis told Affco shareholders that this was an ongoing problem for New Zealand meat firms and it was not easy to see a solution in the short term.

He said trading conditions remained difficult, farm-gate prices were high and the interim result would be below expectations. Mr Lewis also indicated that a dividend was unlikely.

Affco expects a better second half but the meat industry faces a difficult future because of falling sheep and beef cattle numbers, and fierce competition among producers for stock.

The two Talleys' board representatives - the fishing group has a declared 16.7 per cent interest in Affco - did not give anything away when questioned by shareholders. They said their main focus was on Affco's corporate restructuring and they would eventually become more involved in marketing.

Yesterday afternoon, major shareholder Hugh Green lodged a substantial security shareholders notice saying that he had an agreement to sell his 10.1 per cent Affco stake to Talleys at 38c a share, subject to shareholder approval under the Takeovers Code.

Richmond, the other listed meat company, has given a profit warning for its March half-year result. It said stock throughput was down because lambs had lost condition in the wet weather and the excellent growing conditions had encouraged beef farmers to retain stock.

But Richmond expects a much better second half and chief executive John Loughlin said: "We are confident of an overall very good full-year result that will please the market".

These are reassuring words but investors have concerns about Richmond's balance sheet and the company's ability to repeat last year's net profit of $20.7 million.

The group had negative operating cash flow of $29 million last year and inventory and receivables of $208.2 million at September 30 compared with $151.9 million a year earlier. The increase in stocks and debtors was mainly financed by the issue of $50 million 10.75 per cent capital notes.

If Richmond's balance sheet problems can be solved, and last year's earnings repeated this year, then the company's shares are undervalued. But the fall in sheep/beef cattle numbers and the poor historic performance of listed meat firms suggests Richmond has to establish a consistent earnings record before it receives wide investor support.

Pyne Gould Guinness, formed through the merger of Pyne Gould and Reid Farmers, reported net earnings of $4.6 million for the December six months.

Last year, the group had net earnings of $9.5 million.

The new company has considerable scope to improve on these numbers as the 12-month figure included only four months of the merged group and eight months of Reid Farmers.

Pyne Gould is a company worth watching, especially with George Gould, the former successful chief executive of South-Eastern Equities, at the helm.

Wrightson reported a net profit of $6.3 million for the December six months compared with just $1 million for the same period last year. Last year, the group had net earnings of $16 million, giving the stock a relatively low price/earnings ratio and high dividend yield. The dividend is fully imputed.

Shareholders are now benefiting from the 1998 share repurchase programme, where 20 per cent of the company's shares were bought back at an average price of 43c.

But can the improvement in earnings be sustained? Wrightson is cautiously optimistic but investors are concerned at the decline in revenue in the latest six-month period, a more subdued outlook for the dairy sector and the group's volatile history.

Williams & Kettle, which will probably release its interim result next week, has been one of the better performing companies on the Stock Exchange in the past twelve months.

Chief executive Gerard Weenink told shareholders at the November annual meeting that trading for the first quarter was 20 per cent up on the same period last year.

This bodes well for next week's result and illustrates that the stock and station companies, which sell product to farmers, have been doing far better than the meat companies, which have to buy livestock from farmers.

Dairy Brands, the corporate dairy farmer, has a price/earnings ratio of only 1.1 but this is misleading because profits from the sale of its farms are included in earnings. Dairy Brands has unconditional sales contracts for its remaining four farms and these are due to be settled in June.

The company has a net tangible asset backing of 60c a share, including proceeds from the farm sales to be settled in June. Directors are looking at several options on completion of the sales, including a share buyback.

On Monday, Fonterra announced its result for the November six months. The dairy giant reported revenue of $7 billion and a net profit of $2.9 billion. The reported profit was before the payment for raw milk supplied and the distribution of profits to shareholders.

The result was in line with revenue and net profit forecasts of $14 billion and $6 billion respectively for the full year, but second-half earnings are expected to be lower.

The dairy industry has had several good years and total dairy cattle numbers have increased from just under three million to 4.3 million over the past two decades.

But the Fonterra result indicates that the industry is facing more difficult times.

Butter and skim milk prices have dropped sharply over the past six months. Fonterra has reduced its payout forecast for the season from $5.40 to $5.30 per kilogram of milk solids and has indicated it could be as low as $5.20. Last season the pre-merged companies paid $5 per kilogram.

The preliminary payout forecast of $4.50 per kilogram for the next season indicates that the good times for the rural sector may be coming to an end, at least temporarily, and reduced farmer spending will curtail the strong profit growth of Pyne Gould Guinness, Williams & Kettle and Wrightson.

* Disclosure of interest: Brian Gaynor is a Wrightson shareholder.

* bgaynor@xtra.co.nz